We’ve looked at the market through various complex lenses recently: market breadth, momentum, sentiment, etc. but let’s return to a simpler analysis and consider just the tape.

Ascending Wedge
Whether we look at the S&P 500 in the short term or medium term, there is a clear rising wedge pattern that is about to complete. The tops (marked by red arrows) correspond to each instance that daily price has deviated from its long term trend by at least 19% (What Happens This Far Above the 200 Day Moving Average?). And the lower trend line joins the lows in July and late October.

The expected conclusion to this pattern is a break down. However, keep in mind that it is possible for it to resolve either by petering out (continuing sideways) or with higher prices.

We last saw this pattern in the S&P 500 index just a few months ago: Comparing Wedge Formations, Then & Now. The market didn’t break down from that wedge formation but actually continued to meander and for the next two and a half months the S&P 500 basically went nowhere.

Flag Pole Consolidation
The other technical pattern we can see in the short term is a flag consolidation (blue lines in the chart). For several weeks now, prices have been treading water at the 1100 level. Since expansion follows contraction in the markets, the longer this contraction in price continues, the more forceful will be the trend out of it.

Usually a flag formed after a strong up move, like the one from the November/December lows, is a sign of further gains to come. But the more dominant ascending wedge pattern suggests lower prices. A break below 1075 would signal the completion of the wedge.

Price Momentum Oscillator
Stepping back and looking at the market in the long term, the proprietary PMO (Price Momentum Oscillator) indicator from Decision Point has recently given a rare positive signal:

Since 1987 there have only been a handful of similar signals from this indicator so it is difficult to argue based on the sample size. But whether you decide to listen to the PMO or not, keep in mind that like the Coppock Curve, which gave the all clear back in May 2009, this is a very long term indicator.

That means it does not preclude the possibility of a stumble or significant correction. Although I set out to just look at the tape, I mention this indicator because it offers us a long term perspective and provides a balance to our more pessimistic, current technical outlook.

Speculative Fumes
There is really no doubt when we look at the fundamentals of this market that we are running on fumes. But we have been for so long that it has become irrelevant. Nevertheless, the disparity of returns between ‘junk’ and high quality equities is simply remarkable.

Ford Equity Research looked at +4000 individual stocks and categorized them into quality quintiles based on their balance sheets, debt levels, earnings history and stability. Those in the lowest quintile, that is the poorest quality, have risen an average of 152% from the March lows while the highest quality stocks have gained only 66%.

When we compare this irrational scenario to past market periods, things look even more disconcerting. Since we do not have detailed ‘quality’ data going back beyond 1970’s Ford simulated that by comparing large caps to small caps - an imperfect but defensible proxy. They found that:

…the 20 percent of stocks with smallest market capitalizations have on average outperformed the largest 20 percent by 72 percentage points — only slightly less than the 85-point disparity between the lowest- and highest-quality issues.

By contrast, in the first nine months of all bull markets since 1926, the average outperformance of the small-cap sector was just 21 percentage points, or less than one-third as much as the disparity over the last nine months…

the pros are buying,hedge funds and institutions whose furious selling who hastened the collapse… The Dow sits 20% above its avg. of the past 200 days…way overbought and they are still buying…when the fire alarm goes off be sure to be near the door when everyone is exiting, feb.march or april is a real possibility…

“By contrast, in the first 6 months of all bull markets since 1926…average outperformance was just 21%”
May I suggest that you should have looked at all bull markets BEFORE 1926, and if their percentage was above 21% then could we not conclude this to be a bear rally?